Preference Shares: Hybrid Financial Instrument

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Common Shares or Bonds (Debt) are the two most commonly known options available for any investor; but investment world has several hybrid financial instruments. Preferred Stock is one such security which has characteristics both of Common Shares and Bonds.

What are Preferred Stocks? : Just like Common shares which are available in the stock market; preferred stocks represent ownership in the company.  Preference shares rank above the common shares when it comes to payment of dividends or distribution of net assets during liquidation. However, preference shares do not share in the operating performance of the company; which means performance of the company does not impact dividend payment for the preference shareholders and generally it is higher than common shareholders. In this sense; preference shares can be considered to be similar to bonds; bond holders receive fixed interest payment (Coupon).

While preference share holder get fixed dividend at regular interval which con be considered to be advantageous but preference share holder do not have voting rights just like common shareholders unless mentioned specifically.

Comparison of Common shares and Preference Shares:

Preferred Shares Common Shares Bond
Ownership of Company Yes Yes No
Voting Rights No Yes No
Price of Security Is Based on: Earnings Earnings S&P Rating
Dividends Fixed Varies Fixed
Value if Held to Maturity Full Varies Full
Order Paid if Company Defaults Second Third First

 

Key properties of Preference Share:

  1. Hybrid Security: Preference shares are known as hybrid security as they have characteristics both of common shares and bonds.
  2. Dividends: Preference shareholders get fixed dividend which is generally higher than common shareholders.
  3. Convertible preference shares: Certain preference shares can be converted into common shares where one preference shares can results into specific number of common shares.
  4. Participating preference shares: Participating preference shares are entitled to get fixed dividend plus an additional dividend in case company perform more than expected; which is not the case with non-participating preference shares.
  5. Cumulative Preference shares: Dividends on cumulative preference shares accrue so that if the company decides not to pay a dividend in one or more periods, the unpaid dividends accrue and must be paid in full before dividends on common shares can be paid.
  6. Trading: Preferred shares trade the same way common shares trade usually through a brokerage firm. Because of the difference in properties of common shares and preference shares differ thus price may also differ.

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